Spruce Point Capital Management is pleased to announce it has released the contents of a unique short idea involving TSO3 Inc. (TSX: TOS / OTC: TSTIF or “the Company”), a Canadian manufacturer of low-temperature sterilization systems to eliminate microbial contaminants that cause infection. We have conducted an extensive fundamental and forensic accounting review, and believe TSO3 is an over-hyped Canadian healthcare stock destined to fail; its financial presentation, accounting, and limited disclosures obscure the pressures it is facing selling and installing its product to end market customers.
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As a result, we have a "Strong Sell" opinion and a long-term price target of approximately C$0.25 - C$0.50 cents per share, or approximately 80% to 90% downside risk.
Spruce Point Is Short TSO3 (TSX: TOS / OTC: TSTIF) For The Following Reasons, Sees >80% Downside:
TSO3 Inc. (“TSO3” or “the Company”) makes low-temperature sterilization systems to eliminate microbial contaminants that cause infection. Founded in 1998, TSO3 is a regular stock promotion that has repeatedly disappointed investors by failing to broadly commercialize its product and show a profit. Déjà vu, now on its 3rd attempted generation STERIZONE VP4 and its 3rd sales/distribution partner Getinge (previous partner 3M sued it), TSO3 is again baiting investors, who’ve bid its share price up 6x since 2014. Our fundamental and forensic analysis suggests investors should brace for disappointment and >80% downside
1 TSO3 Is Just Another Canadian Healthcare Promotion: The Canadian markets are littered with recent examples of healthcare stocks in need of urgent medical attention, wounded from over-promotion, questionable practices, and poor performance. Short sellers made early warning calls on many names down >80%: Valeant, Concordia, Nobilis, CRH Medical
2 Disclosure Issues & Obfuscating Its Actual End Market Sales: TSO3 is not disclosing its installed base and the reason is obvious – if it did, investors might see just how poor its product’s end market acceptance actually is. In Q3’16, TSO3 suggested it would provide clarity on its installed base in early 2017 – investors are still waiting…. TSO3 even stopped disclosing consumables sales in Q2’16. It currently recognizes as revenues shipments to Getinge, its 3rd party distributor (183 units since Q1’16). However, our math and field checks suggest at best 10 units are actually installed at end customers (95% difference to shipments)
3 TSO3 Using the “Partnership” Playbook To Hype Its Potential: Déjà vu, TSO3 is repeating a twice failed playbook. Recently from 2009-2013, alongside of 3M: TSO3’s single product cycle ended with no material sales, termination of their partnership, and a legal settlement in favor of 3M. TSO3’s prior two generations of this product also failed (the current 3rd generation VP4 appears eerily similar to the 2nd generation – not surprising given the low R&D spend)
4 TSO3 Overstating Its Total Addressable Market (TAM): All good promotions involve baiting investors with big addressable market opportunities. TSO3 appears to have overstated its true market potential by >30% units and C$170m. We provide evidence of the Company playing fast and loose with its numbers
5 Getinge Is Not The Solution To TSO3’s Problems: Bulls think the new Getinge sales partnership is the catalyst needed to spark a run towards C$87m in sales and C$0.22c of EPS in 2020. In reality, Getinge can walk away from the partnership for various reasons, and owns competing sterilizers that likely generate better margins. Getinge has actually purchased 9 sterilization companies prior to this glorified agreement with TSO3, including a low temperature solution called Stericool. Meanwhile Getinge has its own problems: its stock is down to multi-year lows, it has been forced to restructure, and churn through various CEOs, It is also going through an FDA investigation into quality control at its plants, and a regulatory inquiry by Brazilian authorities for alleged cartel activities
6 Outclassed By Larger, Better Capitalized Incumbent Competition, TSO3 Stands Little Chance: Sterrad, owned by Johnson and Johnson (J&J), is the industry leader with a product that is cheaper, better on functionality and maintains a market leading installed base for >20 years. TSO3’s has hyped investors on the potential of solving the superbug issue at hospitals – FDA presumably disagrees as it has recommended four potential solutions, none of which include TSO3’s product (VP4). TSO3’s markets that its key value add is the VP4’s ability to sterilize scopes that no other device can; except it quietly recognizes that the VP4 may be damaging the medical devices being sterilized – an admission that the current generation may be doomed
7 Mgmt & Employment Issues: TSO3 management owns less than 1% of the company’s shares, and has no alignment with investors. Their main incentive is to collect bloated salaries, and care little if TSO3 continues to stuff shareholders with losses.
Management itself is quite poor: its last CFO (Benoit Deschamps) left after its apparently pivotal 510k approval – another ominous sign. TSO3’s new CFO Glen Kayll was a board member at Argex Titanium (a failed stock promotion). CEO Ric Rumble was director at Bioexx which is now delisted. Employees typically know best: we estimate almost one third of TSO3 employees have left the Company since early 2015. The majority of employees that left lasted less than 18 months
8 Everything Must Be Executed Perfectly For TSO3 To Hit Lofty Analyst Goals And Price Target: To be long shares of TSO3, investors are ascribing a near certain likelihood that it will (i) displace current technology and entrenched incumbents, (ii) Getinge will win sales and push TSO3 ahead of competitive products (some that it owns), (iii) It will capture >30% of the market;
(iv) it will surpass an 18 year track record of failure, and (v) it will achieve margins that no one else has in the space. Investors must also gain comfort around TSO3 specific risks: that it is a one product company that could be damaging medical devices, has a history of failed partnerships, no meaningful sales or evidence it can turn a profit in its long history, questionable disclosure practices, and limited alignment with insiders which own <1% of stock
9 Valuation Downside Risk Potential 80%+: Our downside scenario likely plays out with Getinge walking away from TSO3, and not being willing to purchase anything further. In the absence of additional sales growth, TSO3 will continue to accumulate losses (cumulative life-to-date losses are $128m given it has spent 2x as much on SG&A than R&D over the same time period). TSO3 currently trades at a preposterous 15x LTM sales and 19x book value, but bulls point to it being “cheap” at 2.7x and 12x sales and EPS in 2020. We believe that TSO3 is nothing more than a stock promotion, and it cannot generate a profit. Investors wanting exposure to sterilization products are better served owning a basket of peers which are profitable, pay dividends, and trade around 2x sales and book value on average. Ascribing a similar multiple range to TSO3 would result in 80%+ downside risk
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